Canada’s productivity trap

TheGlobeandMail.com – Opinions – The harder we work, the less rich we seem to be. We need to emphasize education, innovation and trade to break free Published on Friday, Jan. 29, 2010. Last updated on Saturday, Jan. 30, 2010. Kevin Lynch

There are few issues that evoke a blank stare more than productivity. Upon hearing the word, people either react with lack of interest or recoil in fear that what is coming is a lecture on working harder. The result is an absence of any serious public discourse in Canada about productivity.

It is time we faced some uncomfortable facts. Canadians have been collectively incarcerated in a beguiling productivity trap for almost a generation. We work harder and harder, use up our natural resources faster and faster, while the trap keeps us less rich, less able to provide public goods and less competitive. Canadians see more people working and goods being produced as proof that productivity is not a problem. Yet this is the beauty of the productivity trap: While the illness worsens, the patients believe they are feeling better.

For several decades, the Canadian medicine chest has been filled with a depreciating exchange rate, unsustainably strong U.S. demand, rising commodity prices and an increasing labour supply. These have kept the symptoms at bay. But with a Canadian dollar over 95 cents, weak U.S. and European demand, uncertainty about energy prices, and growing demographic pressures, a Canadian business-sector productivity level that has fallen to just 75 per cent of the United States means that the productivity trap may be painfully sprung.

The facts of Canada’s poor productivity performance are well established, but not well known or understood. Unlike a fiscal deficit or unemployment or inflation, productivity cannot be measured directly. Unobservable it may be; unimportant it is not. A more productive economy grows faster, adapts better to changing circumstances, leads to lower prices, higher wages, and more jobs, improves living standards and affords more public goods.

There are two paths to the improvement of a country’s standard of living. One is to have more people working, so that in total we produce more “stuff.” The second is to improve productivity, so that each worker produces more “stuff.” With demographics that ensure fewer future workers, the trap means that we won’t be able to drive growth and raise living standards unless we increase productivity, something we have not done well recently.

Start with a statistical glimpse of productivity growth in our business sector. There was strong 4-per-cent average annual growth over the first postwar quarter-century (1947-1973), a much weaker 1.6-per-cent average pace over the next quarter-century (1973-2000) and a tepid 0.8-per-cent average growth rate recently (2000-2008). Comparing countries by output per hour worked per worker, Canada was an astounding 17th among OECD nations in 2007. Since Canadians work more hours than the OECD average, our total output per worker ranked 8th among OECD countries, but worse than the United States. Canada’s business-sector productivity in 2007 was 75 per cent of that of the U.S, compared to 90 per cent in the early 1980s.

Next, take a sectoral perspective. From this vantage point, U.S. productivity performance was particularly strong in the manufacturing sector, and concentrated in information and communications technologies. The U.S. service sector also sustained consistently higher productivity growth than Canada’s for more than a decade.

One explanation that was advanced in the 1990s to explain the gap was the sorry state of Canada’s macroeconomic fundamentals. Our national debt was the second-worst in the G7; our deficits never-ending; our national pension plan in trouble; our bonds and stocks bore high-risk premiums; and the corporate tax rate was significantly higher than our largest trading partner’s. These were not conditions encouraging to investment in productivity, Canadian businesses argued, and they were correct.

Fast-forward a decade. Canada’s debt is now the lowest in the G7, our national pension plan is actuarially sound, macroeconomic risk premiums have disappeared from our stocks and bonds, and Canadian corporate tax rates are 12.5 percentage points below those in the United States. Despite this, business-sector productivity growth was actually worse in the decade just ended.

THE DOLLAR’S IMPACT

Consider the possible impact of the long decline in the Canadian dollar. A lower dollar paradoxically improves competitiveness but reduces wealth. It encourages business to use more domestic inputs and fewer imported inputs, which the lower dollar makes more expensive. Since Canadian business imports much of its machinery and equipment, firms employed more labour and less capital than their competitors. This reduced short-term costs, but impaired medium-term productivity, as business used older capital and less innovative technologies. This orientation saw Canadian business invest relatively little in home-grown research and development, and spend relatively little to license leading-edge technologies developed elsewhere.

A key source of U.S. productivity growth has been the development and production of information- and communications-related goods, and subsequently the broad application of these throughout the U.S. economy, particularly in the service sector. Sustained increases in service-sector productivity have a profound effect on the economy; services account for 80 per cent of the U.S. economy and 70 per cent of ours. Unfortunately, the intensity of usage of information technologies by Canadian business is only half that of the U.S.

International comparisons again demonstrate the research gap between Canadian businesses and their competitors. In 2007, Canadian business ranked 14th among OECD countries in research and development expenditures as a percentage of GDP. Canadian business spending on R&D was only 1 per cent of GDP, well below the OECD average of 1.6 per cent, roughly half of what U.S. business spends as a percentage of GDP and about a third compared with Sweden, Finland and Korea. This suggests that Canadian business has less capacity to be receptive to innovation, and less of a focus on innovation as part of integrated business strategy in Canada.

DEMOGRAPHICS AND DEMAND

If Canada’s business productivity were near parity with that of the U.S., a Canadian dollar near parity would not be as stressful as it is. Moreover, the demographic crunch of a declining working-age population is looming. So is the shifting of demand away from our traditional markets, as the global economy adjusts to the rise of Asia, the financial crisis and the worldwide recession. All these developments underscore the need for urgency in tackling our productivity underperformance.

What will not work are one-off approaches, small fiddles to address a systemic problem and the view that it is someone else’s responsibility. In short, a continuation of the status quo will not work. What is needed is behavioural change by Canadian businesses in their long-term strategies, and a shared sense of purpose by business, governments and the research community. A concerted productivity strategy should encompass innovation, the labour force, markets and attitudes, bearing in mind that there is no single or simple or immediate fix to this structural problem.

Innovation is a driver of productivity growth, creating the new products and processes that will allow Canadian business and workers to move up the value-added chain and compete on quality, service and uniqueness, not merely on cost. Canadian business spending on research cannot remain below the middle of the OECD pack if we are to spur innovation on the scale needed. Our public research capacity has improved greatly, but we need to focus on building global centres of research excellence, better commercialization of our research efforts to create jobs and wealth, better models of business-university partnerships, and better market-based means of financing the application of innovation, particularly a stronger venture-capital market in Canada.

Innovation and a highly skilled work force go hand-in-hand in driving productivity in a knowledge-intensive, global economy. Our aging demographics mean that fewer people will be working in the future; it is simple arithmetic that everyone will have to be more productive just to stand still. In a knowledge-based economy, high school completion and rigorous minimum literacy standards should be givens, not aspirations. We have fewer Canadians with university degrees than many of our competitors, fewer still in scientific disciplines, and we have to design new incentives to encourage the education outcomes we need as a nation. Immigration can offset our demographic trends, but its labour-market effectiveness depends on attracting skilled immigrants.

ENLARGING OUR MARKETS

Canada’s trade linkages are akin to those of a cautious portfolio manager who is overinvested in traditionally safe markets. With the rise of Asian behemoths such as China and India, Canada needs a market enlargement strategy that includes new economic partnerships with the “Asian triangle” of China, Japan and India, expansion of Canada’s Americas strategy to Brazil and a new economic arrangement with Europe. Canada should pioneer new partnership agreements oriented more to the treatment of services, investment, R&D, intellectual property and dispute-settlement arrangements.

Canada is a market-based economy where productivity gains must come largely from business. Governments should place more emphasis on speed, agility and frameworks to support productivity, and less on process and entitlement. Markets need more competition to spur faster adoption of new technologies. Better interaction between university researchers and business is key; in this, Sweden offers useful lessons. More emphasis on trade is essential; we are a trading nation, but not a nation of traders. In short, attitudes matter, they influence behaviour, and we must be strategic.

The global context Canadians face is complex, uncertain and changing structurally. It places a premium on firms, sectors and countries that are flexible, have solid fundamentals and anticipate change. Innovative and productive economies will have a better chance of sustained growth, rising living standards and good jobs. These are the challenges and opportunities for Canada to break out of its productivity trap.

Kevin Lynch is the former clerk of the Privy Council and secretary to the cabinet.